I’ve been posting some critiques of the Massachusetts public pension system, mostly the perks available to special interests who get the attention of the Legislature, but that’s not the whole story. No, I don’t mean that there is more to the corruption angle, although I don’t doubt that, especially in the investment side of the business, with dozens of local retirement boards regularly wined and dined by investment companies, there is much more corruption that deserves to be exposed.
What I mean is that the Massachusetts public retirement system, despite the special perks, is a good deal for Massachusetts, for the following reasons:
(1) At the present time, most public employees’ retirement contributions are self-funding — that means that their own contributions, invested prudently, will fund their retirements, without any contribution from public employers.
(2) The deficit in the sytems derives primarily from the system’s debt, the old pay-as-you-go system that didn’t put aside funding for future obligations.
(3) There is no affordable alternative. If we scrapped the present system, public employees would have to join the Social Security system, which would actually be more expensive than the present system.
(4) For those who advocate for a 401(k) type system that is prevalent in the private sector, they don’t take Social Security into account. Private sector employees with 401(k) plans also have Social Security benefits, and those employees, and their employers, pay into the system. No way can the public sector in Massachusetts afford both Social Security and 401(k) plan contributions.
(5) Because of our public sector retirement sytem, Massachusetts public employees who are also eligible for Social Security benefits get far less Social Security benefits than other individuals — their Social Security benefits are offset by their Massachusetts public pension benefits. Someone like me, when and if I ever retire, will get very little from Social Security, maybe $200 per month.
The financial perks within the system aren’t sufficient to make the system insolvent, but they justifiably undermine public confidence in the system and threaten it. The real issue in public pensions, like our transportation mess, is that we have not paid the bills as they have come due, but, instead, have passed them on to future taxpayers. But we can never deal with that issue, the real issue, without rebuilding public confidence.
It is important to view this issue without the normal insults of “hacks” and try to evaluate this based on the merits.
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p>Your point about this system being cheaper than having employees entering the social security system, how do you figure that? I am asking because I don’t know if it is true or now. Does anyone have information on this point?
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p>I am concerned about the way benefits are calculated. Why is someone’s pension determined from their top three years of salary? What is the policy rationale for three years?
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p>And with the unfunded pension liability, why aren’t all employees asked to increase their contributions to eliminate said liability? Instead the newer employees are asked to contribute are higher percentage of their salaries than their fellow workers who started years before them.
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p>For social security, people pay the same percentage tax on their salary. For the MA pension system, a worker that started in 1980 may be contributing 5% of their salary to the pension system, while a newer employee could be contribution 12%.
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p>That different contribution structure is not a sustainable model. Is this going to eventually be 20%?
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p>Those are my points that don’t seen to be explored in this pension reform debate. Maybe others can offers some explanations to convince me that the MA pension system is fair and properly designed.
…Could the state’s pension system in some ways be cheaper than if it switched to a 401K system with SS benefits?
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p>The answer is “No” when you’re talking about the current generation of retirees and current active employees with 20+ years. But soon they will be phased out and replaced with generations of workers that pay 9-12% of their salary into a pension and virtually fund their own retirements.
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p>Switching over to a 401K system would require between a 1-3% contribution rate from the taxpayers at a minimum, plus now the extra costs of providing social security.
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p>The deciding variable, of course, is how long the retirees live since the state pension is an annuity and the 401K is a fixed pool of money.
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p>I would be interested to see an acturial study of where the break-even point would be on this.
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p>I’m not sure that’s true.
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p>Assume a 9% contribution rate on a salary that’s keeping pace with inflation, say 3%. 25 year old starts work today, expecting to retire at age 66. That’s a FV factor of 19.354, meaning for every $1 of salary, the retiree would have $19.35 of money accumulated at retirement. i.e. $30,000 hire; $580,500, 40,000; $774,000, and so on.
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p>Then, retiring with the $580,500 nest egg, and amortizing it over his life expectancy, the retiree would annuitize the sum over his life at $46,000 per year.
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p>However, in fact, this hypothetical employee will net about $63K (65% of high 3 years) assuming the existing Chapter 32 rules don’t change. The additional $17K per year is available only if the State ‘contributes’ approximately 5.23% in addition to the employee’s 9%.
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p>So not only must the taxpayers make up the hideous underfunding for past sins, but also have to contribute, even to a 9% contributing employee in order to meet promised pension amounts.
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p>I’m not opposing to State employer contributions. I think it’s essential to keep pace with the private sector, but it’s inaccurate for a 9% contributor to claim that’s he’s 100% funding his pension.
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Gary – Although I’m no actuary, I’ll take your conclusion at face value that a 9% employee rate alone would require a State contribution of 5.23%. But that leaves out several other important factors:
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p>(1) All employees hired since 1979 pay an additional 2% contribution on salary over $30,000. So, for employees averaging $60,000 per year, the State contribution presumably declines to 4.23%.
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p>(2) Teachers have a special retirement option that requires them to contribute 11% of their salary (plus 2% over $30,000). So, for most teachers hired today who retire with a full pension, the State contribution would decline to 2.23%.
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p>(3) All public employees who leave public service before they have 5 years of creditable service only get back their accumulated retirement contributions, without interest. That means that the retirement system gets to keep those contributions, invest them, and keep all the accumulated interest. Employees who have at least 5 years of creditable service but less then 10 years get only 50% of the statutory interest rate on their accumulated contributions set by PERAC. That rate, as far as I can tell, is really low, and no where close to the interest earned by retirement boards on their investments. In some cases, like teachers, I have seen data claiming that 50% of teachers leave the profession within 5 years – so the Teachers Retirement System is keeping all the interest that accrues on those teachers contributions.
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p>When you add all these factors together, I still believe that employees hired since 1996 will largely fund their retirement costs without employer contributions. Like our transportation system, it’s not the present costs of our public retirement system that are strangling us, but the accumulated debt.
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p>But, even if I overstate the case, the employer contibution for Social Security is 6.2% (with a cap somewhere over $100,000). Abandoning the present public retirement system, therefore, will, even under your assumptions, Gary, cost the state more because of Social Security, forget about matching 401(k)’s like many private sector workers now have. I agree completely with reforming our public pension system, with far more extensive changes than those that Governor Patrick has put on the table for immediate action. But any case for reform must start from the premise that our public pension system, despite its faults, is the fiscally prudent approach for retirement for our public employees.
Scrap the idea that one day into a new year entitles you to credit pension to the entire year. Either require that the employee actually work for a majority of the year or round to the next month rather than the next whole year.
I need to think about this further, but great work.
You’re coming close to treading on my monniker. Tread lightly… grrrr… woof… or I may bite.
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p>Territorially yours,
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p>YD
Check the records, Yellow Dog. My handle dates back to February 2006, while your’s dates only from December 2006. I preceded you by 10 or so months. Now who’s treading on who’s moniker?
I agree this should be topic should be addressed in isolation from the b.s. gaming of the system by legislators and insiders. Indeed, from the perspective of an average, mid-level employee, the situation is considerably more complex, especially if he or she is a more recent hire.
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p>The “pros” to a system like the one we have are pretty straightforward. In theory, it works the same as if every employee saved money with every paycheck and then purchased an annuity when they retired. But, the main benefits are:
1) that through pooling their resources, the employees benefit from efficiencies — i.e., a better ROI due to scale and bargaining power; and
2) by pooling their investment, the employees are insulated from individual or systemic market risk — the former being someone who makes bad investment decisions, the latter being October 2008.
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p>A corollory to the market risk is the smoothing out of returns over time. If employees had to purchase an annuity on the day of their retirement, a lot would depend on market gyrations: the employee who retired in March 2000 or October 2007 would receive a windfall, whereas an employee who retired in March 2009 or September 2002 would be completely screwed.
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p>And, of course, a huge benefit to the workers is that the state stands behind the system and, in essence, bears the risk that the fund cannot meet the minimum returns necessary to keep the system running. This is also the biggest problem to the taxpayers.
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p>But there are also a lot of “cons” to the system:
1) encourages employee “lock-in” to reach the optimal amount of pension benefit. Anyone who has worked in government knows about this problem: unhappy or disgruntled employees simply will not leave until they have 20 years time.
2) minimum vesting disincentivizes short-term stints in public service. This is especially the case because this time is not creditable toward Social Security either.
3) because benefits are paid years in the future (vs. 401ks, in which the money is transferred in real time), politicians and state leaders face tremendous incentives to push problems off into the future, when it will be someone else’s problem.
4) because the system is determined by the legislature, they face tremendous public choice pressure to provide “extra” benefits or special rules to certain blocks of employees. Everytime the legislature moves away from universal rules (set percentage contribution, set percentage of average salary at retirement age), the system becomes more complex.
5) this, in turn, creates incentives for everyone to game the system to their maximum advantage and to pressure the legislature for benefits to their group, shifting more and more costs onto the public. So every year, you see tweaks to classifications, minimum service, end-of-career capstone jobs, etc.
First, deal with the underfunding. Consolidate the 100+ funds across the state and re-establish a date in the future to cure the shortfall with periodic contributions.
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p>Then, eliminate the pension for new hires.
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p>Last, if the State is concerned with market risk to retirees under the new plan, just establish a 401(k) for new hires, mandate a percentage they have to save, add an employer match, and invest the employees’ money into a PRIT managed portfolio and guarantee a minimum rate, say 4%, of return over the life of the investment.
Gary – I don’t believe that we can abolish our public pension system without getting into Social Security which, as I explained above, would be more costly than the present system.
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p>While the idea of 100+ pension systems with their own separate investment pools is absurd, there are some well-managed local boards that do well by their members. That’s why I supported Governor Patrick’s proposal to make underperforming systems turn over their investments to PRIM.
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p>Real reform of our system, however, would do something about the short-term employees who leave the public sector with less than 5 years of creditable service and get nothing back on the interest that accrues on their contributions. That is unquestionably unfair. I think that the real challenge, after making the short term fixes — like doing away with the one year of creditable service that legislators get for one day of service in a calendar year — and the long term fixes — like Michael Jonas proposes, doing away with termination retirement pensions for all public employees — is to make the system more relevant to our new workforce, with more portable benefits, mroe flexibility. But we can’t get there until we fix the system’s repugnant abuses.